8 pitfalls in compensation planning

Over the past several years, I have been working with firms to develop performance-driven compensation plans. Basically these are plans that pay a base salary to partners and staff at, or perhaps even above, market value. Performance or incentive pay is then provided when the individual and/or the firm exceeds their goals.

Having now done enough of these plans, I have recognized that there are certain pitfalls that all firms should avoid when developing or changing their compensation plan. There may, of course, be others, but these are the ones that often sidetrack a plan.

Let's look at eight major pitfalls and what you can do to eliminate them:

1. Being unable to measure the goals. The cardinal rule is that you must be able to easily capture the information that you want to track. If you can't do it, or if it will cost more time and energy than it's worth, then hold off using that measure.

For example, individual write-downs are very difficult to measure unless you have specific budgets for each person on the team.

2. Having too many measures. The second-most common mistake in developing compensation plans is having too many measures. These plans become cumbersome from an administrative perspective and can also become too complex (see No. 5, below). Just think: If you have four or five goal areas and two goals in each area, that's eight to 10 measures that you are tracking.

3. Having the wrong goals. Many times, firms will select the wrong measures. For example, you may be tracking the number of referral meetings, rather than the number of referrals received, or if a firm tracks new business revenue and not the profitability of the new business. If you don't see the results that you expected, then most likely you are tracking the wrong goals.

The typical example is measuring charge time (time that is entered into work in progress). Everyone will dump as much time as possible into WIP. What happens is that the firm writes down more of it and ultimately bills out less.

4. Driving the wrong behavior. You will know if you have some wrong goals when you're not seeing the right behavior or the expected behavior from your people.

5. Too complex. If everyone in the firm cannot explain the plan in simple terms, it's too complex. A complex plan is usually not followed, doesn't give you the desired results and won't change individual behavior. Plans become too complex when you try to cover every contingency or when the plan is different for different people.

6. No differentiation between top and average performers. Pay-for-performance or incentive-pay programs are all about paying the top performers more than the rest of the team. You need to make sure that the difference is significant; otherwise, the top performers won't stay at the firm.

7. Keeping poor performers with the firm. A good pay-for-performance system weeds out underperformers. General Electric, for instance, would eliminate the bottom 10 percent of their performers each and every year. Does your plan accomplish this?

8. Lack of regular updates. While you don't have to make major changes to the plan each year, you do want to update it on an annual basis. With any new plan, you will also be making adjustments and corrections after the first year

Remember these pitfalls and build your plan taking them into consideration. The more time you spend up front in developing a solid compensation plan, the more successful your plan will be.

August Aquila is the author of several marketing and management books and is a consultant with more than 25 years of experience to the accounting profession. Reach him at (952) 930-1295 or at aaquila@aquilaadvisors.com.